14 – L1 12 How An Index Is Constructed V2

Let’s see how an index is constructed and updated to see where the index number comes from. The Hang Seng Index was created by a banker, Stan Lee Kuan at Hang Seng Bank in 1969, and tracks the 50 largest companies that are listed on the Hong Kong Stock Exchange. The index selected the 50 largest companies that were traded on the Hong Kong Stock Exchange and added up their market capitalization. Then, they set that sum equal to 100 points for the index. So the index began in 1969 with the number 100. Note that we will refer to the sum of market caps of all these 50 companies as the total market cap. Each trading day, the percent change of the total market cap is multiplied to the previous day’s index, to calculate the index for that day. For example, let’s pretend the total market cap on the very first day was 100 billion Hong Kong dollars. The following day, let’s say the total market cap changed to 102 billion. Recall that we can get the percent change by taking the current day divided by the previous day. So in this case, 102 billion divided by 100 billion is 1.02 or a 2% increase. If we multiply the first day’s index of 100 points by 1.02, the second day’s index value is now 102 points.

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